This week has been a busy one for company trading updates. But one that really stood out to me was from oil major BP (LSE: BP), which reported on its trading for the first half of 2019. Even though oil prices fell during the second quarter, the company managed to beat expectations, thanks to improved oil production and what management called a “very strong” gas marketing and trading performance.
Rising profits
Underlying replacement cost profits — analysts’ favourite metric for tracking oil companies profitability — came in at $2.8bn for the second quarter. Analysts had been expecting an income of $2.5bn.
The results also include the production figures from the acquisition of BHP’s US shale assets, which boosted BP’s oil production 7% in year-on-year to 2.6m barrels of oil equivalent per day. Cash flow from operations rose to $6.8bn, up around $0.5bn on the year.
Unfortunately, despite the general improvement in the company’s operation, BP’s net debt jumped in the quarter to $46.5bn, from $38.7bn a year ago. However, management is planning to sell $5bn of assets during the second half of the year, which should help strengthen the balance sheet and allow for greater distributions to shareholders.
The potential of additional cash returns is the primary reason why I want to add BP to my stocks and shares portfolio. The stock already supports a dividend yield of 6.2%, but there’s plenty of scope for the payout to grow from its current level.
Share buybacks could also be on the cards. After deducting capital spending from the company’s $6.7bn of cash flow for the second quarter, free cash flow came in at $3.1bn, giving a dividend cover ratio of 150%, according to analysts at Morgan Stanley. This implies BP has around $1bn of free cash flow a quarter available for additional distributions.
Balance sheet troubles
I’d like to see BP clean up its balance sheet before buying into the stock. Management decision to acquire BHP’s US shale business seems to have been the right one, but it’s left the company with quite a bit of debt.
Plans to reduce borrowing with asset sales will lighten the load. I’m excited to see what the balance sheet looks like in six months when the company has offloaded its $5bn of non-core assets.
According to BP’s chief financial officer, when borrowing starts to reduce meaningfully, it will be a “signal for the board” to start looking at additional shareholder distributions. It could be several months before those are announced but, as I’ve noted above, the company has scope to increase its dividend or buy back stock to a value of up to $1bn a quarter. Higher oil and gas prices will allow for even more flexibility and cash returns.
And as well as the potential for increased cash returns, the stock also looks cheap. It is currently dealing at a forward P/E of just 12. After taking all of this into account, I’m planning to add BP to my Stocks and Shares ISA. I think you should consider doing the same as well.
